Tuesday, 30 April 2013

The New FTSE 100 Cyclically Adjusted Price Earnings Ratio (FTSE 100 CAPE) Update - April 2013

Welcome to the new look UK FTSE 100 monthly stock market review which includes a couple of valuation metrics.  The last time we looked at this dataset was on the 10 March 2013.  This monthly review will now loosely follow the same format we use for the S&P 500 which will enable us to get some consistency across regions going forward.

FTSE 100 Price

At market close on Tuesday the FTSE 100 was priced at 6,430.  That is a rise of 0.8% when compared with the 01 March 2013 Price of 6,379 and 9.5% above the 02 April 2013 Price of 5,875.  How this pricing compares with history can be seen in the chart below.

Chart of the FTSE 100 Price
Click to enlarge

This is a similar chart to that which you will see in many places within the mainstream media.  Let’s now remove the sensationalism by:

  • Correcting the chart for the devaluation of the £ through inflation.  For this dataset I use the Consumer Price Index (CPI) to devalue the £.
  • Plotting the Pricing on a logarithmic scale as opposed to a linear one.  By using this scale percentage changes in price appear the same.  

Looking at the chart this way reveals the FTSE 100 in a very different light.  That light shows that the compound annual growth rate (CAGR) in today’s £’s has only been 2.0%.  Correct it by the Retail Prices Index (RPI) and that falls to 1.2%.

Chart of the Real FTSE100 Price
Click to enlarge

FTSE 100 Earnings

As Reported Nominal Annual Earnings are currently 483, up from 458 on the 01 March 2013.  They are down 18.3% on last year and 23.0% on October 2011’s 628.  Or course this looks better than it really is as inflation flatters the result.  I therefore plot a chart below, again on a logarithmic axis, showing Real (inflation adjusted) Earnings performance over the long term.

Chart of Real FTSE 100 Earnings
Click to enlarge

This only tells half of the Earnings story as it is an absolute number and so doesn’t help us with assessing market value.  Let’s therefore divide the nominal Earnings by the nominal Price to calculate the Earnings Yield.  Today that’s 7.5% and can be compared with history in the chart below.

Chart of FTSE 100 Earnings Yield
Click to enlarge

FTSE 100 Dividends

Dividends matter.  Today annual dividends for the FTSE 100 are 226.  The Real inflation adjusted growth of FTSE 100 Dividends, which is what many long term buy and holders including myself are looking for, can be seen in the chart below.  Unfortunately I only have dividend data from 2006 but with time that will grow and it’s better than nothing.

Chart of Real FTSE 100 Dividends
Click to enlarge

If we divide Dividends by Price we get the Dividend Yield which is currently 3.5% and can be compared with history below.

Chart of Real FTSE 100 Dividend Yield
Click to enlarge

Valuing the FTSE 100 – The Price/Earnings Ratio (P/E or PE) and the Cyclically Adjusted Price/Earnings Ratio (aka PE10 or CAPE)

Many people use the FTSE 100 P/E as a valuation metric.  It’s actually nothing more than the inverse of the Earnings Yield shown above.  Today it sits at 13.3 which is down on last month’s 13.9.

Personally I prefer to use the FTSE 100 CAPE.  It was made famous by Professor Robert Shiller, who used it on the S&P 500, and it is the ratio of Real (ie after inflation) FTSE 100 Monthly Prices to 10 Year Real (ie after inflation) Average Earnings.  Today the FTSE 100 CAPE is 13.0 which is identical to its value on the 01 March 2013.

Both valuation metrics are shown in the chart below.

Chart of the FTSE 100 Cyclically Adjusted PE and FTSE 100 PE
Click to enlarge

Does it work?  Well only time will tell but what I can say is that history suggests it has some value.  If we look at a history of 5 Year Nominal Capital Gain of the FTSE 100 and compare that with the two valuation metrics we find:

  • The P/E has a correlation of -0.28 which is considered a weak or low correlation.
  • The CAPE has a correlation of -0.45 which is considered a moderate correlation.  So it’s not perfect but it’s better than P/E when looking over longish periods which suits an investor like me.

A chart showing historic CAPE to 5 Year Capital Gain is shown below.  With the CAPE at 13.3 the trendline implies a person buying today could expect a future Nominal 5 Year Capital Gain of around 65%.

Chart of the FTSE 100 CAPE versus 5 Year FTSE 100 Capital Gain
Click to enlarge

Some other CAPE metrics that may be of interest:

  • The correlation between the Nominal FTSE100 Price and the FTSE100 PE10 is 0.20.  This is considered a weak or low correlation.  The correlation between the FTSE 100 Real Price and the FTSE 100 PE10 is a much more impressive 0.66.  This is considered a moderate correlation bordering on a strong or high correlation.
  • The Dataset Average FTSE 100 PE10 is 19.0.  Assuming this is “fair value” it indicates that the FTSE 100 is 32% undervalued today.  I’m not so comfortable with this call and think that may be a function of the fact that the dataset is quite short.  I therefore rely on there being a high correlation between International Equities and UK Equities to make a correction for this short period.  My mature S&P 500 dataset shows that from 1881 to present we have seen an average PE10 of 16.5 and from 1993 to present (the length of my FTSE 100 dataset) we have seen a much higher average PE10 of 26.4.  If I ratio these two numbers and multiply by the Average FTSE 100 PE10 I get a pseudo “long run” Historic FTSE 100 PE10.  Doing the maths this is (16.5/26.4)x19.0=11.8.  Comparing that number with today’s PE10 of 13.0 suggests a 10% over valuation
  • The Dataset Median FTSE 100 PE10 is 19.3.
  • The Dataset 20th Percentile S&P 500 PE10 is 14.1.
  • The Dataset 80th Percentile S&P 500 PE10 is 23.0.

Making Personal Investment Decisions from this Data

My Retirement Investing Today Strategy drives tactical allocations from CAPE values.  It uses the FTSE 100 CAPE to set my allocation to the UK Equities portion of my portfolio.  This is strategically set at 20% of total wealth.  By adding the FTSE 100 CAPE tactical spin on top, as detailed in the Strategy, it forces a lower tactical allocation target of 18.8% today.

As always do your own research.

Assumptions include:

  • UK CPI inflation data for March and April 2013 is estimated.


  1. I'm a little confused.

    Current PE10 FTSE is 13.3 and the historic average is 19. This would imply that PE10 FTSE is low today and you should invest more than you usually would. Yet you say:

    "This is strategically set at 20% of total wealth. By adding the FTSE 100 CAPE tactical spin on top, as detailed in the Strategy, it forces a lower tactical allocation target of 18.8% today."

    Shouldn't you be higher than 20% because current PE10 FTSE is low?

    Thanks for the clarification!

    1. Hi rjack

      The problem I have is that the dataset is only 20 years old for this Index which may be to short a period to be truly meaningful historically. Today the CAPE is 13.0 (the PE is 13.3) against an average of 19. Based on the dataset as it is we see a 32% under valuation.

      As I mention above I then extrapolate with the S&P 500, relying on a high correlation between the two, to give a 'pseudo' long run series. After extrapolation the average lowers to 11.8. Now we have a 10% over valuation. Thus I'm underweight.

      Which is the correct answer? Only history will tell us but I personally am using the extrapolated 'pseudo' long run series.


    2. Thanks! I should have read more carefully.

      Do you have an article that discusses the correlation between the S&P 500 and FTSE 100?

    3. Hi rjack

      Hale in his Smarter Investing book (full details under Books That Helped Me tab above) suggests the correlation between UK Equities and International Equities is about 0.9.


  2. Vanguard suggest that the correlation is closer to 0.5 for US and UK equities for the period 1970 - 2005:


    Still a reasonable correlation, but maybe not close enough to extrapolate?

    CAPE for UK market is a headache given the limited data. Instinctively, I feel the UK market is better value than the US given the data that is available.

    PS I find these updates very useful - thanks

    1. Hi Gravitas

      Interesting information from Vanguard. I've just compared the correlation of my FTSE100 to S&P500 datasets covering the period July 1993 to present. Correlation = 0.94 which is even better than that suggested by Hale.

      As I'm sure you are aware these datasets have a slight difference in how they are constructed. The S&P500 is a month average price where the FTSE100 is a first possible day of each month price.

      I agree that no matter whether the FTSE100 CAPE is extrapolated or not it still suggests it is currently better value than the S&P500


  3. Interesting look at market timing:
    (Not the process used here butt sobering nonetheless.)